Why Demand Matters More Than Supply

Supply and demand are at the core of introductory microeconomics. We learn that price and volume are determined by the intersection of these two factors. However, hotel supply and demand in the real world rarely function at this long-term equilibrium. Supply is fixed in the intermediate term, and demand can fluctuate wildly throughout the year.

A solid understanding of hotel demand and where it is coming from is critical to evaluating a new investment. Further, your strategy to attract and retain the most lucrative guests for your hotel is of paramount importance to ensure long-term success.

Supply is Guaranteed, Demand is Not

Existing hotel supply reflects historical demand. A new hotel takes 15-18 months to build, up to a year to get government approvals to build, and unlimited time to get a hold of the dirt. Guest needs and desires change over this time, so it’s sometimes a challenge to hit the mark. Still, the developer and major brands work hard to create timeless designs and experiences to keep up.

After you assess existing supply, it’s time to get a good idea of demand. Property and centralized sales teams will have a good idea of business targets, and the existing segmentation gives you an understanding about how guests find the hotel. You can expect this demand to fluctuate throughout your investment period.

No Control Over Demand

Demand for your hotel is completely out of your control.

You have no control over guest decisions to stay in your hotel. However, you have limitless opportunities to influence these prospective guests through smart sales and marketing.

Modern sales and marketing are evolving to emphasize product over branding, advertising, and face-to-face sales. Guest service, the built environment, and overall experience are the “product” in a hotel. This is what guests will be talking about with family and friends when they return from their trip. Further, its execution builds or destroys loyalty.

Travelers have more stay-over options than ever before. Every brand is targeting unique experiences and guests within their latest prototypes. Homesharing services, like Airbnb and HomeAway, are intensely competing for guest wallets. And social media and OTA reviews judge each hotel individually.

Transparency and options continue to increase in the travel sector. Operators must adapt to the new normal with an increased focus on creating a remarkable experience regardless of chain scale. You may not have control over the guest, but you can create a product that resonates with them.

Business Cycles

Hotel supply and demand play together over time in an opaque environment. A new hotel results from a gap in supply to meet existing or projected demand. Information is incomplete in the best cases for these development decisions.

The trade press routinely criticizes hotel developers for overbuilding, especially amid a market correction. Critics fail to recognize that new hotel supply overcomes many barriers to become reality. Many astute third parties, including lenders, government entities, and institutional investors, contribute to the plan.

The stark reality is that business cycles reflect demand fluctuations. That is, a recession results from a lack of demand rather than excess supply.

Consider the classical microeconomics supply and demand chart. The intersection of hotel supply and demand is the current equilibrium. A recession shifts the demand curve down.

Supply is fairly inelastic. Some hotels may close or put rooms out of service for renovations, and many homesharing options may disappear in a recession. Still, the room nights available in a market don’t change much from quarter to quarter. Consequently, the reduction in demand has a greater impact on price than quantity supplied.

Market Health Indicator

Overnight stays are the primary service influencing hotel supply and demand. Function hosting and catering are big business in full service hotels, but most hotels strictly focus on accommodating guests on a nightly basis. This demand for room nights comes from naturally occurring demand for goods and services in the community.

Demand Diversity

Points of interest vary from natural resources, like beaches and oil, to built environments, like office and amusement parks. Each demand driver brings a different type of traveler with diverse needs and desires. These points of interest then combine in countless ways to make each guest abundantly unique.

The most robust hotel markets are comprised of a diversity of leisure and business travel demand.

Business cycles impact a submarket in different ways. New attractions at Walt Disney World or Universal Orlando highly influence a destination like the Orlando theme park corridor. The demand in this area is completely different than that generated by the college seasonality across town in the University of Central Florida submarket.

Many investors prefer investing in urban markets, like New York, Los Angeles, and Miami, because they have multiple types of leisure and business demand. A wide variety of potential guests helps mitigate demand risk, even though a general economic correction impacts all industries in these markets.

New York City, for example, has more hotel rooms than some states (it also has more demand). All businesses recognize the importance of having a presence in this city. Therefore, an extraordinary correction in one industry does not necessarily impact demand within others. Further, the presence of counter-cyclical industries in a market provide stability when the world is burning.

Growth Matters

Stock and flow are two critical considerations in evaluating hotel supply and demand dynamics. Stock is what exists today, and flow is growth expectations for the future. It should be obvious from the mini economics lesson above that demand growth is essential because supply is mostly fixed.

The world is more open and connected than ever. Modern communications and travel options make keeping loyal visitors and attracting new business and leisure guests a challenging task. Therefore, economic development offices, chambers of commerce, and tourist boards, among others, solely focus on this mission.

Consider demand growth from two angles – consistency and special events.

Businesses and attractions that generate consistent or seasonal demand are critical for laying base business. These demand drivers provide area hotels with a reliable block of room nights each year with little expectation of slow down.

Special events, on the other hand, offer opportunities for supply shortage and rate compression in the market. An event like the Super Bowl or a major convention increases demand for a temporary limited supply of hotel rooms. This allows hotels to charge higher rates before, during, and after that event.

Airbnb rose out of these hotel supply and demand dynamics in the notoriously supply-constrained San Francisco convention market.

Revenue Solves All Problems

Eric Schmidt, Executive Chairman and former CEO of Google, is famous for saying, “Revenue solves all problems.” This can be surprising coming from a tech firm that didn’t make any money for the first few years of its life. However, he proved that growth is only possible when you have the means to keep the lights on.

Revenue is Like Water

Revenue is the lubrication for all the operation’s needs and desires. At the most basic economic level, a sustainable hotel must bring in enough revenue to cover fixed costs, like taxes, insurance, and ground leases. Beyond that, the marginal cost of a room night sold must be less than the rental rate to be profitable.

Revenue flows down the profit and loss statement like a waterfall. Each line item takes its share along the way based on contractual and operational obligations. It eventually settles and pools at the bottom of the financial statement as net operating income.

Hotels with insufficient revenue do not perform at their greatest potential. Think about your own performance when dehydrated. Your mouth dries out, skin cracks, and you lose mental sharpness. You lose your ability to do the things you love. It’s the same with a hotel.

Without enough revenue, hotels lack the ability to delight guests. They can’t invest in concepts to enhance loyalty or hire the best talent.

Expenses, on the other hand, can flex to increase profitability once the revenue picture stabilizes.

The Business of Hotels

Hotels are in the business of temporary lodging at their core. The Nativity story from the Bible is the most legendary of all hotel stays. You could never put a pregnant woman out to sleep with the cows today, but it speaks to the basic utility of a hotel – lodging.

Modern hotels must be more than just lodging, though. Guests are increasingly demanding unique experiences when they visit a new town or try a different hotel. They want to align with brands that share their values and management companies that clearly care for their comfort.

This is not too far from the genesis of the modern hotel brand. These companies gained notoriety in the post-WWII world because of consistent quality. Still, hotels evolved from simply clean and safe cookie-cutter rooms to innovative room concepts and experiential public spaces.

The evolution of personalized experiences will drive demand at the micro level in the future. Personalized loyalty offers and warm, AI-assisted guest interactions will differentiate industry leaders from laggards. The margin between these two is where the revenue opportunity lies for the early adopters.

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